This is a blog about the future of digital media law from Laurence Kaye. Laurence runs Laurence Kaye Consulting Limited (click here), bringing insight an clarity to the complexities of the digital world.

October 01, 2012

When is a sale not a sale, and vice versa?

Dear reader

Imagine going into a car showroom, signing
the paperwork to buy a car and driving away, with neither you nor the dealer
being exactly sure what the deal was.
You thought you had bought the car and were therefore free to either
keep it or sell it. The dealer, on the
other hand, thought that you didn’t own the car outright and couldn’t sell it
on without his permission.

This never happens – right? Well, in “the
real” world probably not, but in the world of creative content and software, it
does happen.

Take the recent controversy surrounding
Bruce Willis where he was allegedly upset that he was unable to bequeath his iTunes
library to his children. Although press
reports of Bruce’s threats to exercise serious courtroom muscle against Apple
turned out to be unfounded, the story did highlight a very important issue – when
it comes to purchases in the digital world, be it software, mp3s, e-books or
anything else, are we all making purchases without knowing exactly what the
deal is?

3 key lessons

A recent
ruling by the European Court of Justice (ECJ) involving software publisher Oracle
and UsedSoft, a vendor of pre-owned software
licences, has highlighted that in the case of software downloads there really
is widespread confusion on both sides of these transactions regarding what
rights a buyer walks away with after purchasing software. As we’ll see, the case demonstrates three
things. First, if the economic substance of the transaction is a sale, then
this doesn’t change if the language talks about a limited licence, meaning that
the buyer is generally free to re-sell. Second, even if it is a sale, there is
a big caveat: the owner can still control rental of the software. Put another
way, business models (e.g. ‘software as a service’) built on rental do not
result in loss of control over re-distribution of the software. Third, although
the case related to computer software, there are some important lessons for
other forms of creative content.

It’s all about control

So what was the case all about? Oracle
claimed that UsedSoft had infringed its copyright in the software on the basis
that Oracle’s customers (and subsequently any reseller such as UsedSoft) had no
right to distribute purchased copies of its software by re-selling them. UsedSoft’s position was that, as with cars and
other “real world” purchases, once a customer buys software for lifetime use,
including via download, they have the right to sell it on without requiring any
permission from the seller.

Oracle disagreed. It pointed to its licence terms, particularly
the words “non-transferable”, to argue that real world rules did not apply to
software downloads. As far as it was
concerned, the software had been ‘licensed’, not ‘sold’, so it could still
control what the buyer could do with its software, even after sale.

The case was referred by the German courts
to the ECJ for clarification on certain aspects of the Copyright and Software EU
Directives. We’ll examine the case in a
moment and see whether it applies to other forms of digital content and not
just software. But what is the nub of
the problem? For the software and creative content industries, new business
models are built on licences but, as these cases show, there is a lack of clarity
about exactly what constitutes a “licence”.

So what exactly is a “licence”? What does
the consumer or business customer get? A typical provision in a consumer
service talks about a: “….limited,
non-exclusive, non-transferable, non-sublicensable license to access and make
personal and non-commercial use of the [content]”. This isn’t an academic legal debate
buried in impenetrable online terms and conditions. If a licence is in fact, a
sale, then the consumer is free to give away or sell the content like 2nd
hand goods on eBay. Similarly, if the licensee is a trade customer, it can
re-sell or deal with the digital content without requiring any further
permission from, or payment to, the content provider.

The real moral of the story is that the
creative content industries should not leave it to the courts to “retro-design”
business models. If the substance of the
transaction is a sale then that‘s how it should be described based on the
economic business model. If, on the
other hand, it’s a form of exploitation such as rental then that should be
reflected clearly as well. That was the
lesson in the UsedSoft v. Oracle case
where the bottom line of the ruling was that if a business charges a licensing
fee for software that represents the entire economic value of that copy’s
useful life, whether downloaded or sold on physical media, the transaction will
be treated as a “sale” even if the licence terms state that the licence is
“non-transferable”. It can therefore be lawfully
resold in the same way that a car or any physical product containing copyright
material can be resold as long as the seller first deletes or makes his copy
unusable.

Case background

The ECJ ruling in UsedSoft
v. Oracle clarified two main points on the interpretation of the
Software Directive, namely that:

under
Article 4(2) of the EU Software Directive Oracle couldn’t prevent subsequent
sales of a copy of its downloadable software, including any updates, after it
had charged a fee “corresponding to the
economic value of the copy of the work” on its first sale. The ECJ ruled that by charging fee reflective
of the economic value of the software Oracle had effectively transferred the
ownership of its rights in that copy to the purchaser and therefore had
‘exhausted’ its rights to further distribute, and be further remunerated for,
that copy. So the ECJ agreed with
UsedSoft that the ‘exhaustion of rights’ principle applied. Similar to the ‘first sale’ doctrine in the
US, this principle in EU law restricts the ability of a rightsholder to control
a physical copy of an item containing their work, say a book, by causing that
control to be ‘exhausted’ after the first sale of that copy. It is by virtue of this principle that a
number of traders have lawfully created a secondary market for a variety of
second hand goods, including books, CDs, computer games, computer software,
DVDs etc. However, the court held that the
seller must render his copy of the software unusable (e.g. by deleting that copy)
for the resale to be lawful. Referring
back to our example, it would hardly be fair to the car manufacturer if you could
sell your car and somehow retained the benefit of it.

Oracle
couldn’t prevent a purchaser to whom a copy had been resold (such as UsedSoft
or its customers) from copying the software in order to use that copy because,
although the exhaustion principle does not apply to Oracle’s reproduction
right, under Article 5(1) of the Software Directive a “lawful acquirer” can
reproduce the software to make use of it for its “intended purpose”.

The court did however point out a caveat:
volume licences must be sold as a whole as the partial resale of a multi-user
licence would involve the seller continuing to use a usable copy.

Case analysis

The ECJ ruling marks a considerable shift as
to where the courts draw the distinction between a “licence” and a “sale” by
applying an “economic value” test. By
doing so the case clarifies, at least where software is concerned, that a
transaction where a customer is charged a ‘one time’ fee which represents the
economic value of the software will be treated like a real world sale and not a
time-limited licence or rental. And just as with the sale of a car, this means a
buyer is free to sell the software on to whomever he or she chooses.

But the impact of this ruling may not only
be limited to software publishers. Publishers
of music, e-books or any other digital content sold by download should also take
note: although the ruling specifically concerned the resale of software under
the Software Directive, the reasoning applied by the court to the exhaustion of
rights principle is likely to apply in the same way under the Copyright
Directive. Whilst there is no equivalent
reproduction exception for such works as there is for software under Article
5(1) of the Software Directive, the Copyright Directive does allow for temporary
copying, which would allow for lawful uses of many formats of work e.g. mp3,
e-book etc. once such files were resold.
For more information on this, barrister Tom St Quintin of IP specialists
Hogarth Chambers discusses the various legal issues involved in his post here.

Practical pointers

All businesses in the
creative industries should carefully consider how the test used by the court might
affect their pricing and business models.

In particular they should
think about whether the ‘one-time’ licence fees they currently charge reflect
the value of, in effect, what are now transferable licences, at least in the
case of software. If not, they may wish
to explore rental, hire-purchase models or models based on offering “Software
as a Service” (SaaS), to which the exhaustion of rights principle does not
apply.This ruling will have an immediate impact on businesses that sell
perpetual licenses for a one-time fee, especially to the consumer market where
single-user licences are common. Such
software publishers, are likely to have new competition from the used software
market which can now expand to include used licences for digital downloads
comprising up-to-date, fully patched versions of their software products.

If you’d like any help in applying these
lessons to your own business models, we’d be delighted to help. And, just to
encourage you, for a limited time only we’re offering 30 minutes free phone
consultation.

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